Price Elasticity of Demand (PED) - Summary

Price Elasticity of Demand (PED)

Definition

  • PED is a measure of the percentage change in quantity demanded in response to a percentage change in price.
  • Formula: PED = \frac{\%\Delta QD}{\%\Delta P}

Calculations

  • Example Calculation: If quantity demanded falls by 10% from a 15% rise in price, PED = \frac{-10\%}{15\%}
  • Remember to calculate percentage change as: \frac{change}{original} \times 100

Interpreting PED Values

  • PED > 1: Elastic (demand is highly responsive to price changes).
  • PED < 1: Inelastic (demand is not very responsive to price changes).
  • PED = 1: Unitary.
  • PED = 0: Perfectly Inelastic.
  • PED = ∞: Perfectly Elastic.

Elastic PED

  • Definition: Percentage change in quantity demanded is greater than the percentage change in price (\%[Delta Qd > \%\Delta P).
  • Impact on Revenue: A decrease in price leads to an increase in revenue; an increase in price leads to a decrease in revenue.

Inelastic PED

  • Definition: Percentage change in quantity demanded is less than the percentage change in price (\%[Delta Qd < \%\Delta P).
  • Impact on Revenue: An increase in price leads to an increase in revenue; a decrease in price leads to a decrease in revenue.

Factors Affecting PED

  • Time: PED tends to become more elastic over longer time periods.
  • Competition: More competition leads to more elastic PED.
  • Brand Loyalty: Stronger brand loyalty leads to more inelastic PED.
  • Proportion of Income: PED is more elastic for products that take up a significant portion of income.
  • Necessity vs. Luxury: Necessities tend to have more inelastic PED; luxuries have more elastic PED.
  • Addictiveness: Addictive products tend to have more inelastic PED.

Business Implications

  • Businesses should raise prices if their product has an inelastic PED and lower prices if their product has an elastic PED to maximize revenue.

Issues with Using PED

  • PED may change over time due to changing consumer behavior or new competitors.
  • PED estimations may not be completely accurate.
  • Price is not the only factor influencing demand.